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DUTIES  »/ AUDITORS 

IN  RELATION  TO 

CORPORATION 
AMALGAMATION 


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licrosoft  Corporatior 


The  BUSINESS  MAN'S  PUB 
LISHINO  COMPANY.  LTD 

DETROIT.  ^^<^<^<^«^«  MICHIGAN 


LIBRARY  OF 

ALLEN  KNIGHT 

CERTIFIED  PUBLIC  ACCOUNTANT 
502  California  Street 

SAN     FRANCISCO.     CALIFORNIA 


DUTIES  OF  AUDITORS 


IN   RELATION   TO 


Corporation  Amalgamation 


THE   INVESTIGATION   OF  CJtl^ANIES'   ACCOUNTS 

WITH    A  VIEW    TOj^Syj^LGAMATION 

HOW  TO  DO  XHfeE^XND  WHAT 


THE  RBraW  SHOULD 
'AIN. 


^ 


A   Thesis  presented  before  the  Institute  of  Chartered 

Accountants^  at  Toronto^  Jaiiuary 

15th,  1902,  by 

F.  H.  MACPHERSON,  Chartered Accounianty 
Windsor,  Ontario, 


PRICE,    ONE   DOLLAR. 


PUBLISHED  BY 


The  Business  Man's  Publishing-  Company,  Ltd 


DETROIT,    MICH. 


Entered  according  to   Act  of   Congress  in   the  year   1902. 

By  F.  H.  MACPHERSON,  C.  A. 

Detroit,  Michigan. 

In  the  Office  of  the  Librarian  of  Congress. 

All    Rights    Reserved. 


DUTIES  OF  AUDITORS. 


It  is  not  my  purpose,  nor  was  it  the  intention  of  the  Council 
of  the  Institute  in  selecting  the  subject  for  this  evening's 
paper,  that  I  should  enter  into  a  dissertation 
The  Difference  upon  the  merits  or  demerits,  the  good  or  ill 
Between  to    the     community    of    "Amalgamations," 

Trusts  and  otherwise   known    as   "trusts,"    "combina- 

Amalgamations  tions,"  and  "monopolies,"  or  if  the  terms  be 
used  which  are  applied  to  them  by  those 
more  especially  and  directly  interested,  then  we  shall  speak 
of  them  as  "Judicious  combinations  for  the  public  good," 
"community  of  interest,"  or  "community  of  control." 

Here  I  may  interject  that  the  difference  between  a  Trust 
and  an  Amalgamation  has  been  thus  described:  "The  Trust 
was  designated  primarily  as  a  weapon  of  war,  aggression  and 
attack;  the  Amalgamation  is  primarily  a  measure  of  self- 
defence  and  peace." 

Whether  the  objects  of  Amalgamation  are  desirable  or  the 
reverse,  is  not  wdth  us  the  question;  nor  yet  whether  most 
beneficial  to  the  community  or  to  the  individual.  There  are 
two  sides  to  this,  as  to  every  other  question.  All  will  agree, 
however,  that  the  one  ultimate  end  and  aim  of  those  who  enter 
into  these  combinations,  by  whatever  name  they  may  be  known, 
is  a  desire  to  increase  profit.  This  increased  profit  may  be 
brought  about  in  numerous  ways,  as  by  command  of  the  neces- 
sary capital ;  the  checking  of  competition ;  the  utilization  of 
materials  which  manufacturers  in  a  small  way  cannot  use,  in 
the  manufacture  of  by-products ;  the  introduction  of  new  and 
labor-saving  machinery  whereby  the  cost  of  production  is 
materially  lessened ;  the  saving  of  energy  which  comes  from 
the  organization  of  a  large  business  under  a  single  skilled 
executive  head ;  better  organization ;  the  ability  to  retain  men 
of  peculiar  abilities  upon  the  line  of  w^ork  for  which  they  are 
specially  fitted ;  the  saving  of  expense  in  the  selling  or  disposal 

3 

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of  the  products';  the  spetfaKzilig  of  work — and  with  all  these, 
as  it  was^^^tyby;^th'e  pr^ident  of  the  Standard  Oil  Company, 
is  given  ^'power  to  give  the  public  improved  products  at  less 
prices  and  still  make  a  profit  for  the  shareholders,"  and  to 
provide  "permanent  work  and  good  wages  for  labor. 

In  this  age  of  progress  it  would  seem  that  combinations 
have  become  a  necessity.    This  being  admitted,  the  important 
question  to  be  considered  by  accountants  is 
Combinations         upon  what  basis  shall  these  amalgamations 
a  necessity  be  effected,  and  upon  this  subject  I  shall  to- 

of  the  Age  night  endeavor  to  present  a  few  thoughts. 

"The  Investigation  of  Companies'  Ac- 
counts with  a  view  to  amalgamation.  How  to  do  this  and 
what  the  Report  should  contain." 

For  the  purposes  of  this  paper  I  shall  change  the  order  of 
the  sentence  "How  to  do  this  and  what  the  report  should 
contain,"  and  make  it  read :  "What  the  report  should  contain 
and  how  to  do  this,"  or,  the  requirements  having  first  been 
ascertained,  how  proceed  to  obtain  the  information  required. 

The  first  point  to  receive  consideration  is  the  position  of  the 
accountant  with  respect  to  the  extent  of  the  examination  which 
he  is  called  upon  to  make.    Usually  the  in- 
Status  of  the  structions  are  very  general  in  their  terms ; 

Accountant  in  some  instances,  however,  they  are  suffi- 

ciently specific  as  to  leave  no  room  for  the 
exercise  of  any  discretion.  As  an  illustration :  Recently  I 
was  asked  to  make  an  investigation  of  two  concerns  (about 
to  amalgamate)  for  the  purpose  of  ascertaining  what  the  rev- 
enues and  expenses  of  operation  of  the  respective  properties 
had  been  for  a  certain  period.  I  was  not  to  concern  myself 
with  the  matter  of  assets  and  liabilities.  The  value  of  the 
former,  and  the  sum  of  the  latter  had  been  arranged  as  be- 
tween the  parties  previous  to  my  being  called  in  and  certain 
statements  as  to  profits  had  been  made.  My  sole  duty  was  to 
verify  the  accuracy  of  these  statements  as  to  profits. 

In  "Dicksee  on  Auditing"  it  is  laid  down  as  an  axiom  that 
"an  accountant  cannot  submit  his  professional  discretion  to 
the  dictation  of  his  clients  without  sacrifice 
(Responsibilities     of   self-respect,   and   grave    danger   to    his 
of  the  clients'  interests."    This  is  a  sound  principle 

Accountant  and  one  which  it  is  very  desirable  should  be 

adhered  to.     In  the  great  majority  of  the 


certificates  of  accountants  which  are  found  in  the  prospectuses 
of  companies  forming  to  effect  amalgamations  is  a  bare  state- 
ment as  to  profits  covering  a  period  of  years,  not  of  the  several 
companies  individually,  but  in  the  aggregate.  Each  time  that 
I  see  a  certificate  framed  after  this,  the  prevailing  fashion,  the 
thought  occurs  to  me  that  the  accountant  is  probably  carrying 
out  his  instructions,  and  is  telling  the  truth  in  a  concrete  form. 
But  is  the  whole  truth  being  told?  For  it  is  possible  for  the 
accountants  to  tell  the  truth  and  yet  not  give  expression  to 
the  whole  truth.  The  question  I  next  ask  myself  is:  What 
are  the  responsibilities  of  the  accountant?  We  are  coming  to 
know  and  to  realize,  day  by  day,  and  year  by  year,  that  the 
investing  public  are  learning  to  rely  more  and  more  upon  the 
certificate  of  the  accountant ;  that  as  much  reliance  is  being 
placed  upon  this  as  upon  the  names  of  those  who  stand 
sponsor  for  the  projected  enterprise,  prominent  in  the  financial 
and  commercial  world  though  they  may  be.  It  is  a  recognized 
fact  that  the  flotation  of  any  scheme,  large  or  small,  where 
public  subscriptions  are  invited  is  hardly  possible  in  the 
absence  of  the  certificate  of  a  Chartered  Accountant  of  known 
and  recognized  standing  in  the  community. 

Within  the  past  year  I  have  knowledge  of  three  instances 
of  attempts  being  made  to  float  enterprises  which  were  found 
impossible  in  the  absence  of  the  certificate  of  a  known  and 
recognized  accountant.  In  every  instance  the  flotation  was 
successful,  the  accountants  certificate  having  been  obtained, 
the  enterprises  having  been  found  deserving. 

In  this  view  of  the  case  the  responsibility  which  rests  upon 
the  accountant  is  impressed  upon  me  as  being  so  grave  and 
serious  that  it  cannot  be  treated  lightly.  Knowing  that  upon 
the  strength  of  statements  to  which  we  certify  will  follow  the 
investment  of  hundreds  of  thousands  of  dollars,  the  hard  earned 
savings  of  persons  who  know  little  or  nothing  of  business,  and 
who  depend  upon  the  word  of  the  accountant  as  to  the  possible 
profixt-earning  power  of  the  enterprise  in  which  these  savings 
are  being  invested,  it  behooves  us  as  accountants  to  so  prepare 
our  reports  and  certificates  that  in  case  of  failure  to  realize 
anticipations,  the  blame  may  not  be  placed  upon  our  shoul- 
ders. We  must  do  this  if  the  profession  of  accountancy  is  to 
be  enduring  and  respected. 

W^hat  I  desire  to  impress  upon  accountants  at  this  early 
stage  in  our  consideration  of  this  subject  is  the  necessity  for 


stating  the  "whole  truth."  I  do  not  for  one 
Essentials  moment  wish  it  to  be  understood  that  I  feel 

of  the  or  think  that  failure  to  do  this  is  from  any 

Accountants  desire  on  the  part  of  the  accountant  to  hide 

Report  what  ought  to  be  revealed,  but  for  the  rea- 

son that  his  instructions  limit  him  to  a 
certain  course,  and  because  the  telling  of  the  whole  facts  might 
be  prejudicial  to  the  interests  of  those  who  engage  his  services. 

You  ask  my  definition  of  the  phrase :  "the  truth,  the  whole 
truth,  and  nothing  but  the  truth/' 

I  answer:  that  to  my  mind  the  whole  truth  would  more 
nearly  be  told  if  the  certificate  of  the  accountant  were  to  show 
the  revenues  and  expenditures  of  the  several  concerns  entering 
the  amalgamation  individually,  and  year  by  year,  and  not  in 
the  aggregate.  If  the  profits  are  gradually  increasing,  the 
report  would,  as  it  should  in  all  fairness,  so  show ;  and  on  the 
contrary,  if  a  decline  or  irregularity  in  the  profit-earning  power 
is  apparent,  the  report  should  so  state,  with  the  particulars 
and  reasons  therefor.  This  as  to  the  profit-earning  power.  As 
to  the  valuation  of  the  assets,  the  report  should  show  the 
amount  of  capital  (bona  fide)  engaged  in  each  business.  This 
point,  I  will,  however,  take  up  a  little  later.  If  this  be  done 
the  facts  presented  may  be  perfectly  satisfactory,  or  on  the 
contrary,  they  may  be  such  as  will  have  the  effect  of  deterring 
many  of  those  who  now  do  so,  from  investing  in  shares  of 
over-capitalized  companies. 

It  is  possible  that  the  accountant  who  follows  the  course  I 
attempt  to  lay  down  may  not  receive  very  much  of  this  par- 
ticular class  of  busienss ;  but  he  will  be  certain  to  "come  into 
his  reward"  at  a  later  period,  when  the  liquidator  or  receiver 
takes  a  hand,  and  an  investigation  follows  for  the  purpose  of 
fixing  the  responsibility.  This  phase  of  the  business  will  be 
just  as  profitable,  besides  being  a  good  deal  more  satisfying 
to  the  conscience,  and  the  accountant  will  feel  that  he  has  ful- 
filled well  the  precept  expounded  by  Polonius  for  the  benefit 
of  his  friend  Laertes : 

"To  thine  own  self  be  true 
And  it  must  follow,  as  the  night  the  day. 
Thou  canst  not  then  be  false  to  any  man." 

For  the  purposes  of  this  paper  I  shall  assume : 

(i)     That  two  manufacturing  concerns  in  the  same  line  of 


business  contemplate  amalgamation.  (2) 
Scope  of  the  That  the  report  of  the  accountant  is  to  form 

Investigation  the  basis  of  the  amalgamation.     (3)     That 

the  accountant's  instructions  are  general  and 
not  specific,  and  include  the  determining  of  the  assets  and 
liabilities,  as  well  as  the  earnings.  (4)  And  that  he  is  acting 
for  the  purchasers  and  not  for  the  vendors. 

Accountants  differ  as  to  the  scope  of  an  investigation. 
There  are  those  who  take  the  position  that  the  accountant  is 
not  expected  to  make  the  thorough  examination  which  a  reg- 
ular audit  would  entail,  but  that  the  genuineness  of  the  boks 
and  of  the  balance  sheet  should  be  assumed.  Others  consider 
that  the  accountant  pursuing  an  investigation  would  wish  to 
analyze  the  accounts,  and  that  in  doing  this  we  would  dis- 
cover fraud,  if  any  had  been  committeed. 

Regular  audits  and  special  investigations  have  or  should 
have  the  same  end  in  view:  the  obtaining  of  a  correct  state- 
ment of  facts.  The  first  is  for  the  purpose  of  verifying  the 
balance  sheet  put  forward  as  presenting  the  condition  of 
affairs  of  the  business  under  review,  for  the  safeguarding  of 
the  interests  of  the  shareholders  or  proprietors.  The  second 
(if  on  behalf  of  a  projected  company)  is  for  a  similar  purpose, 
viz :  the  ascertaining  the  value  of  the  assets,  the  liabii'ties,  and 
the  profit-earning  .power. 

For  myself,  I  cannot  well  see  how  an  accountant  can  accept 
and  prepare  a  report  from  any  balance  sheet  without  satisfying 
himself,  by  a  sufficient  analysis,  of  the  regu- 
Statement  of  larity  of  the  accounts  and  of  the  methods 

Assets  and  followed  to  produce  the  various  items  which 

Liabilities  enter  into  the*  assets  of  a  concern,  or  which 

Illustrated  go  to  make  up  the  revenue  and  expenditure 

accounts. 

Leaves  from  experience  are  of  more  practical  value  than 
volumes  of  theory. 

Take  the  following  statement  of  assets  and  liabilities  pre- 
sented to  me  recently  for  an  examination  and  report.  The 
revenue  and  expenses  were  the  subject  of  a  second  statemnt. 


Assets. 

1  Cash  an  hand  and  in  bank $    1,345  40 

2  Bills  receivable   9j953  42 

3  Advertising  due  bills 1,521  95 

4  Mdse.  on  hand.. 10,000  00 

5  Machinery  and  fixtures 33^204  45 

6  Property   and    franchises 209,765  82 

7  Accounts  receivable   2,260  81 

8  Insurance  accrued    166  86 

$268,218  71 

Liabilities. 

9  Bills  payable   $    9,029  45 

10  Accounts  payable    i,447  89 

11  Reserve  account    7,74i  Z7 

12  Capital  account    250,000  00  . 

$268,218  71 

Items  I  to  5  and  7  and  8  of  the  assets  presented  no  difficul- 
ties in  the  way  of  verification.  Item  6  (property  and  fran- 
chises) required  investigation  and  analysis  which  revealed 
the  fact  that  it  represented  nothing  but  a  patent  v/ith  three 
years  yet  to  run,  and  the  balance  ''water"  in  the  capital  ac- 
count. Shorn  of  these  the  resources  of  the  company  were 
$58,452,  and  the  liabilities  on  trade  account  $10,477;  cash  in- 
vestment of  shareholders  $40,234,  and  surplus  $7,741 

I  mention  this  case  for  the  purpose  of  emphasizing  my  posi- 
tion that  it  is  rarely,  if  ever,  safe  to  assume  the  correctness  of 
the  balance  sheet,  and  the  accountant  who 
What  the  will    certify,   without   an    examination    and 

Accountant's  analysis  in  detail  sufficient  to  satisfy  himself 

Report  shouldJfci|^^tjiH^rboi^  fides  of  the  items  which  enter 
Contain.  --  rm^CS^wiiiiWment  as  assuming  a  responsi- 

bility from  which  I,  for  one,  should  wish  to 
be  excused. 

Statements  of  the  concerns  should  be  included  in  the  report, 
independently  of  each  other,  and  based  upon  the  foregoing 
specifications  should  contain  information  as  folows: 

(i)  Assets  as  of  a  given  date  (the  same  in  each  instance) 
divided  as  to : 

(a)  Realty. 
•     (b)   Plant  and  machinery. 

(c)   Merchandise  (raw  material). 

8 


(d)  Merchandise  (in  process). 

(e)  Merchandise  (finished  product), 
f)    Leasehold. 

(g)   Good  will, 
(h)  Patents. 

(i)    Accounts  receivable, 
(j)    Bills  receivable, 
(k)   Cash  on  hand  and  in  bank. 
(1)    Bills  receivable  under  discount  (Indirect), 
(m)  Accrued  interest,  insurance,  etc. 
(n)  And  such  other  divisions  of  the  assets  as  the 
nature  of  the  business  might  demand. 

(2)  Liabilities,  as  of  a  given  date  (the  same  in  each 
instance),  divided  as  to : 

(a)  Bills  payable. 

(b)  Accounts  payable. 

(c)  Mortgage  indebtedness. 

(d)  Bills  receivable  under  discount  (Indirect). 

(e)  Other  indirect  liabilities. 

(f)  Capital  account. 

(g)  And  such  other  divisions  of  the  liabilities  as  the 

nature  of  the  business  might  demand, 

(3)  Revenues  and  expenses  of  each  business  showing  earn- 
ing power  of  each  in  a  given  time  (usually  three  years  if  the 
business  has  been  in  operation  so  long)  and  preferably  cover- 
ing the  same  period. 

Taking  the  items  in  these  divisions  in  their  order,  the 
accountant  will  ordinarily  not  be  called  upon  to  verify  items 
"a"  to  *'h,"  the  land,  buildings,  stock-in-trade,  leasehold,  etc., 
being  specially  valued  by  independent  valuers.  If  not,  and 
these  are  subject  to  verification  by  the  auditor,  he  should  in 
the  case  of :  -"- 

(a)  Realty,  call  for  the  title  deeds  and  see  that  the  account 
is  not  charged  up  with  fictitious  increases  in  value,  or  with  the 
annual  taxes,  as  I  have  found  in  certain  instances,  and  that  a 
sufficient  allowance  has  been  made  for  depreciation  in  build- 
ings, etc. 

(b)  Plant  and  machinery,  a  certified  inventory,  which 
should  agree  with  the  sum  set  down  in  the  balance  sheet,  care 
being  taken  to  verify  extensions  and  additions,  and  a  compari- 
son of  prices  with  the  original  invoices  and  that  due  allowance 
has  been  made  for  depreciation,  and  obsolete  plant. 

9 


(c),  (d),  (e)  Merchandise,  raw,  in  process,  and  the  finished 
product,  certified  inventories,  which  should  be  checked  both  as 
to  quantities  and  values — an  independent  appraisement  is  alto- 
gether preferable ;  comparison  of  inventory  with  invoices  in  the 
case  of  raw  material ;  to  see  that  profits  are  not  anticipated,  a 
careful  inspection  of  cost  accounts  is  required.  In  case  of  man- 
ufactured stock  care  must  be  exercised  to  see  that  office  and 
selling  expenses  are  not  pro-rated,  and  added  to  the  cost  of 
goods  appearing  in  inventory.  Note  should  be  taken  of  the 
"dead  wood"  in  the  stock  and  that  proper  allowance  has  been 
made  to  cover. 

(d)  Leasehold,  not  usually  a  consideration,  but  if  found  to 
exist,  a  special  valuation  to  ascertain  present  value  is  best; 
otherwise  the  original  cost,  less  proportionate  reduction  for 
the  expired  period. 

(g)  Good  will,  this  item  can  only  be  determined  by  agree- 
ment between  the  parties,  and  is  one  which  does  not  seriously 
concern  the  accountant,  except  that  if  it  is  put  in  at  an  arbi- 
trary sum  by  the  vendors,  he  should  see  to  it  that  the  price  be 
set  forth  separately  and  distinctly  in  the  "assets"  so  that  the 
purchasers  may  know  just  how  much  they  are  expected  to  pay 
for  the  same. 

(h)  Patents.  See  that  these  are  entered  at  their  proper 
present  worth — which  will  be  determined  by  the  remaining 
life  thereof,  and  the  present  "state  of  the  art"  in  that  partic- 
ular connection. 

(i)  Accounts  receivable.  A  careful  examination  should 
be  made  to  ascertain  the  condition  of  these,  that  they  are  alive 
and  collectable,  and  that  proper  provision  has  been  made  for 
bad  and  doubtful.  Also  that  secreted  in  the  accounts  receiv- 
able may  not  be  found  charges  for  "goods  on  consignment" 
billed  out  at  the  usual  profit,  and  going  to  swell  the  volume 
of  output  thus  unduly  increasing  the  earnings,  by  the  "antici- 
pation of  profits." 

(j)  Bills  receivable.  Same  examination  as  in  the  case  of 
accounts,  so  far  as  prospects  of  realization  are  concerned. 

(k)  Cash  on  hand  and  in  bank.  The  same  verification  as 
in  a  regular  audit. 

(1)  Bills  receivable  under  discount.  This  is  an  indirect 
asset  as  well  as  an  indirect  liability,  and  it  is  important  in  the 
case  of  an  amalgamation  where  the  liabilities  are  being  as- 
sumed, that  information  on  this  point  should  be  given  and  it 

10 


may  be  necessary  that  some  allowance  should  be  made  in 
anticipation  of  "loss  upon  realization." 

(m)  Accrued  interest,  insurance,  etc.  That  the  claim  for 
these  is  fair  and  proper. 

Turning  next  to  the  question  of  liabilities,  we  take  up : 
(a)  (b)  Bills  payable  and  accounts  payable.  The  verifi- 
cation will  be  the  same  as  in  a  regular  audit.  In  this  connec- 
tion it  may  be  proper  to  say  that  there  is  not  much  danger  of 
the  liabilities  being  over-stated.  The  principal  danger  lies  in 
the  understating  or  not  taking  to  account  of  the  outstanding 
liabilities,  and  this  must  be  carefully  guarded  against  if  the 
transfer  of  the  business  involves  the  assuming  of  all  the  lia- 
bilities. 

(c)  Mortgage  indebtedness.  Verification  by  the  obtaining 
of  a  statement  from  the  mortgagees,  both  as  to  principal  and 
arrears  or  accrued  interest. 

(d)  Bills  receivable  under  discount.  The  remarks  under 
item  "L"  in  assets  would  more  properly  come  in  here,  the 
same  being  applicable  in  both  cases. 

(e)  Other  indirect  liabilities.  These  may  be  in  the  nature 
of  endorsations  (although  a  strictly  improper  and  illegal  pro- 
ceeding in  the  case  of  joint  stock  companies)  claims  for  dam- 
ages, disputed  accounts  for  materials,  services  or  commissions. 
A  distinct  statement  in  writing  as  to  the  existence  or  non- 
existence of  these  should  be  obtained  from  the  proper  officers 
of  the  company. 

(f)  The  value  of  the  business  to  the  purchasers  will  be 
represented  by  the  difference  between  the  assets  and  liabilities 
in  each  case  and  if  profitable  should  equal  the  issue  of  capital 
stock  with  an  addition  to  the  assets  of  any  undivided  profits, 
which  would  enhance  the  value  of  the  equity  to  be  transferred 
to  the  amalgamating  company. 

The  question  of  revenue  and  expenses  of  operation  will  in 
all  probability  more  particularly  occupy  the  attention  of  the 
accountant,  rather  than  the  ascertaining  of 
Verification  the  value  of  the  assets  and  liabilities;  in 

of  Revenue  fact,  as  I  have  stated  before,  his  instructions 

may  limit  him  to  the  determining  of  these 
without  regard  to  the  other. 

Taking  the  revenue  accounts  first:  the  accountant  will 
require  to  make  a  careful  investigation  of  the  receipts  for  the 
period  (usually  three  years)  under  examination.     He  will  see 

11 


that  no  extraneous  revenue  has  been  introduced  and  that  the 
progress  in  the  revenue  account  has  been  consistent  and 
steady,**  or  otherwise.  He  must  be  watchful  that  the 
revenue  account  has  not  been  increased  by  credits  for 
goods  "on  consignment'*  with  an  off-setting  entry  to  ac- 
counts receivable.  In  a  recent  case  open  accounts  of 
$45,000  were,  upon  investigation,  found  to  contain  consign- 
ments to  the  extent  of  over  $30,000,  upon  which  gross  profits 
exceeding  twenty  per  cent,  had  gone  to  the  credit  of  revenue, 
thus  enhancing  that  account  by  over  $6,000.  This  occurred 
during  the  last  year  of  the  three  under  examination.  Of  course 
a  very  substantial  increase  in  turnover  and  profits  was  shown, 
which  was  purely  fictitious.  Other  points  which  require  to  be 
looked  into  are,  that  goods  "on  approval"  likely  to  be  returned 
to  stock  afterwards,  have  not  found  their  way  into  the  sales 
account,  that  fictitious  sales,  for  the  purpose  of  swelling  the 
revenue  have  been  put  through  the  books,  and  shipments  not 
made  before  close  of  inventory;  that  incompleted  and  un- 
shipped orders  have  not  been  credited  to  sales  account,  thus 
inflating  revenue  by  ungained  profits ;  that  rebates  and  allow- 
ances are  a  charge  against  sales  and  not  an  addition  to  mer- 
chandise account.  In  a  word,  the  bona  fides  of  all  sales  espe- 
cially near  the  end  of  the  period  should  be  determined  to  the 
satisfaction  of  the  accountant. 

It  is  the  duty  of  the  accountant  to  see  that  all  the  expenses 
entered  are  a  proper  charge  against  the  business  and  that  they 
are  made  within  the  proper  period;  that 
Verification  of  there  is  ho  reduction  in  expenses  toward  the 
Expenditures  close  of  the  term  under  inspection ;  that  the 

and  Profits  expenses  are  regular  and  consistent  and  bear 

a  steady  ratio  to  the  turnover;  that  proper 
and  reasonable  allowances  have  been  made  for  repairs  and 
renewals,  and  that  these  are  charged  against  revenue  and  not 
an  increase  to  capital. 

Excessive  profits  from  any  particular  cause  should  be  noted, 
as  for  instance:  those  which  might  arise  from  the  making  of 
heavy  purchases  in  anticipation  of  an  upward  tendency  in 
prices,  and  which  anticipation  had  been  fulfilled. 

That  all  profits  earned  and  taken  to  account  are  incidental 
to  the  business.  A  sale  of  real  estate  not  required  for  the 
purposes  of  the  business,  and  made  at  a  substantial  profit, 
forms  an  example. 

12 


On  the  other  hand  expenditures  of  exceptional  and  unusual 
character  which  have  gone  to  reduce  the  profits  below  normal 
should  be  noted. 

In  the  consideration  of  the  cost  of  operation  heed  should  be 
given  to  the  effect  which  a  limited  capital  has  had  upon  the 
expenses  of  operation.  Lack  of  capital  is 
Cost  of  naturally  followed  by  increased  borrowings, 

Operation  and  increased  borrowings  augment  the  in- 

terest account.  Operation  is  thus  charged 
with  a  sum,  which,  had  adequate  capital  been  invested,  would 
have  been  in  the  nature  of  a  dividend.  By  way  of  illustration : 
I  have  in  mind  a  business  in  which  every  dollar  of  capital  in- 
vested is  borrowed.  This  may  appear  an  extreme  case,  but  such 
is,  nevertheless,  sometimes  to  be  found.  The  borrowed  capital 
represented  $100,000.  Upon  this  sum  interest  was  paid  out  of 
the  business  and  charged  to  operating  expenses.  I  am  asked 
to  investigate,  and  find  this  condition.  In  the  preparation  of 
the  profit  and  loss  account  I  eliminate  the  $6,000,  interest  paid 
on  this  sum  in  order  to  arrive  at  the  earning  power  of  the  busi- 
ness. It  can  readily  be  seen  how  unfair  any  other  course 
would  have  been,  and  how  lack  of  sufficient  capital  in  any 
business  will  impair  the  earning  power  and  affect  the  showing 
as  to  profits,  unless  allowance  be  made  therefor.  There  is  room 
here  for  the  exercise  of  a  display  of  good  judgment  on  the  part 
of  the  auditor  in  determining  what  the  "adequate  capital" 
should  be. 

English  authorities  suggest  that  it  is  part  of  the  duty  of  the 

investigating  accountant  to  ascertain  the  amount  of  Capital 

necessary  to   conduct   the   business   on   its 

Trading  present   lines   and   report   as   to   the   scope 

Percentages  offered  for  increased  capital  investment. 

The  Accountant  should  so  far  analyze  the 
accounts  as  to  enable  him  to  furnish  information  upon  the 
following  points : 

(i)  Proportion  the  stock  bears  year  by  year  to  the  annual 
turnover. 

(2)  Rate  per  cent,  of  gross  profit  in  trading  account  on 
cost. 

(3)  Rate  per  cent,  of  selling  expense  on  cost. 

(4)  Rate  per  cent,  of  Administration  and  office  charges  00 
cost. 


An  analysis  sheet  covering  these  and  other  points  of  a  like 
nature,  in  each  business,  would  enhance  the  value  of  a  report. 

Reports  in  detail  upon  each  business  should  be  prepared  and 
furnished  the  principals,  and  these  should  form  the  basis  upon 
which  the  Amalgamation  is  carried  out. 
Separate  Regard,  of  course,  will  also  be  had  to  the 

Reports  introduction  of  other  interests  where  more 

extensive  operations  are  contemplated  by 
the  Amalgamating  Company. 

In  addition  to  the  report  in  detail  a  certificate  is  usually  pre- 
pared for  use  in  the  prospectus.  This  certificate  is  generally 
barren  of  all  information  except  as  to  the  revenues,  expenses 
of  operation,  and  profit  earning  power  of  the  various  busi- 
nesses entering  the  amalgamation,  and  these  in  the  aggregate. 
Indeed,  certificates  are  not  uncommon  where  information  is 
given  only  as  to  the  profits  earned  by  the  several  businesses. 
It  is  unusual  to  see  any  reference  to  the  amount  of  capital 
invested.  It  occurs  to  me  that  a  model  certificate  would  be 
one  framed  somewhat  after  the  following  style : 

Certification. 

Gentlemen — I  beg  to  advise  that  I  have  examined  the  rec^ 
ords  of  the  Brown  Manufacturing  Company,  Limited,  and  of 
The  Jones  Manufacturing  Company,  Limited,  each  for  a  period 
of  three  years,  and  certify  to  the  correctness  of  the  under- 
written statements,  as  to  Capital,  Earnings,  Expenses  of  Op- 
eration and  Net  Earnings,  covering  the  period  given : 


1898. 
1899. 
1900. 


Brown  Manufacturing  Co.,  Limited 


Net  Capital 
Employed. 


Earnings. 


Expenses  of 
Operation. 


Net 
Earnings. 


Total $ $ $. 

Jones  Manufacturing  Co.,  Limited. 


1898. 
1899. 
1900. 


Net  Capital                                   Expenses  of               Net 
Employed.            Earnings.           Operation.            Earnings. 
? $ $ $ 


Total, 


14 


Combined  Companies. 

Net  Capital  Expenses  of  Net 

Employed.  Earnings.  Operation.  Eaminsrs. 


1808. 
1899. 
1900. 


Total $ $ $ 

For  further  information  reference  is  made  to  my  reports 
in  detail,  herewith. 

JOHN  THOMPSON,  Accountant. 

I  fully  appreciate  that  the  less  detail  which  appears  in  the 
report  the  better,  for  the  obvious  reason  that  much  of  it  would 
not  be  understood  by  the  average  individual,  and  the  tendency 
would  be  to  befog  rather  than  enlighten ;  and  that  this  is  very 
undesirable.  But  I  do  think  that  an  accountant  issuing  a  cer- 
tificate framed  as  above,  with  a  simple  qualifying  reference  to 
a  report  for  further  and  detailed  information  will  be  placing 
himself  upon  safe  and  sure  ground. 

No  reflection  can  fairly  be  made  upon  the  honesty  and  integ- 
rity of  the  accountant  aftervvards,  and  if  such  should  be  sug- 
gested and  an  investigation  be  made  as  to  the  reasons  for 
failure,  if  failure  has  come  upon  the  enterprise,  then  the  more 
rigid  the  examination  the  brighter  and  better  will  appear  the 
position  of  the  accountant. 

In  presenting  these  views,  I  have  departed  from  the  usual 
course  in  some  respects,  with  the  object,  amongst  othei  things, 
of  eliciting  discussion  and  an  interchange  of  views,  as  by  this 
means  only  can  these  meetings  be  made  to  bear  fruit  to  the 
fullest  and  best  advantage. 

In  closing  I  cannot  do  better  than  repeat  the  words  of  i\Ir. 
Fisher,  F.  C.  A.,  President  of  the  Institute  of  Chartered  Ac- 
countants in  England  and  Wales,  who,  in  speaking  recently 
upon  the  subject  of  Accountants  certificates,  has  said: 

"In  a  word,  let  our  certificates  be  plain,  clear,  and  with  no 
uncertain  sound,  avoiding,  as  sometimes  happens,  a  crowd  of 
reservations  and  qualifications,  of  which  it  is  often  difficult  to 
understand  the  meaning.  Let  our  certificates  exclude  every- 
thing that  may  possibly  be  construed  into,  or  even  approach, 
the  appearance  of  a  possible  double  or  doubtful  meaning — let 
our  certificates  be  not  only  true  and  bold,  but  intelligible  and 
understandable  to  all  who  read  them.    Thus  will  the  certificate 

15 


of  the  Chartered  Accountant  become  more  and  more  valued 
and  relied  upon,  and  the  certifying  accountant  commended  for 
keeping  to  facts,  and  not  attempting  to  prophesy,  or  resorting 
to  the  foolish  practice  of  fortune-telling.  To  so  act,  wt  shall 
merit,  and  may  I  not  say,  deserve,  the  confidence  to  enjoy  and 
to  establish  upon  a  firm  and,  of  the  general  public,  which  we 
all  desire,  lasting  basis." 


16 


\'^^-^ 

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